Uwe Kratzsch,
Gernot Sieg
„When to Regulate Airports: A Simple Rule”
Braunschweig : Institut für Volkswirtschaftslehre, 2009
Working Paper Series / Economics Department ; No. 06
Veröffentlicht: 02.06.2009
ECONOMICS DEPARTMENT
WORKING PAPER SERIES
NO 06/ MAY 2009
„When to
Regulate Airports:
A Simple Rule“
by Uwe Kratzsch
and Gernot Sieg,
ay 2009
M
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When to Regulate Airports: A Simple Rule
Uwe Kratzsch∗Gernot Sieg∗ May 26, 2009
Abstract
Landing fees at airports are regulated almost all over the world since airports are assumed to abuse their market power. We find that monopolistic airports have an incentive to restrain landing fees when they generate additional non-aviation revenues and that the optimal landing fee decreases in the degree of complementarity of aviation and non-aviation. Furthermore, we show that monopolistic airports will not have an incentive to abuse their market power anymore so that a price regulation becomes inappropriate as soon as non-aviation rev-enues increase above 50% of all airport revrev-enues.
Keywords: airport regulation; aviation and non-aviation revenues; complementarity of aviation and non-aviation; locational rents
JEL: L93; D42; L51
1
Introduction
Privatized airports are typically regarded to have persistent monopoly power in providing aeronautical services. Hence, increases in the charges for aero-nautical activities, i.e., the provision of landing, take-off, gangway and park-ing capacity for aircraft and passengers, usually have to be approved by regulatory authorities in order to minimize welfare losses. In general, reg-ulation takes place according to principles of cost relatedness or by setting price caps.
In contrast, charges for commercial services that are often provided by franchises and other commercial operators, such as retail, car parking, bank-ing, and caterbank-ing, are usually not subject to any direct form of regulation. The reason is that although airports might have some market power in the
∗
TU Braunschweig, Economics Department, Spielmannstr. 9, 38106 Braunschweig, Germany
2 MODEL 2
non-aviation business and might earn profits from providing commercial ser-vices or from renting property, they could be disciplined by potential com-petition. However, non-aviation revenues can be indirectly considered if regulators opt for applying the single-till approach while approving aero-nautical charges, whereas the dual-till approach confines regulation to the monopolistic bottleneck of an airport, i.e., aviation.
As many countries moved – or are moving – towards privatization of some of their public airports (Basso 2008), the non-aviation business has become increasingly important to airports within the last two decades. On average, non-aviation revenues now account for around half of all revenues (Graham 2009). With regard to this fact, one could doubt that monopolistic airports have an incentive to abuse their market power. High charges for aeronauti-cal activities guarantee high profits in the aviation business; however, lower charges would increase the number of landings, thereby increasing the num-ber of passengers who can make use of the commercial services offered and thus the demand for rented property.
Starkie (2001) was the first who challenged the necessity of an ex-ante
price regulation of monopolistic airports. He argues that airports are unlikely to abuse their market power whenever complementary commercial activities exist because the profitability of those activities will be negatively affected when aeronautical charges are set too high. In contrast, Oum, Zhang and Zhang (2004) point out that although an unregulated profit-maximizing air-port has an incentive to suppress aeronautical charges, it would not set them at a socially optimal level so that a price regulation may be necessary. Hence, Brueckner and Pels (2007) conclude that it is not completely clear that air-ports will actually abuse their market power, in which case the regulation of charges would be inappropriate.
We show that monopolistic airports have an incentive to restrain aero-nautical charges (hereafter referred to as “landing fees”) when they generate additional non-aviation revenues. Landing fees are lower the higher the de-gree of complementarity of aviation and non-aviation at an airport. Further, our model implies that monopolistic airports will not have an incentive to abuse their market power anymore as soon as non-aviation revenues increase above 50% of airports’ total revenues. In such case, a price regulation will become inappropriate.
2
Model
Building on the analysis of Sieg (2009), we consider a non-congested, unreg-ulated monopolistic airport that is approached by an airline. The air carrier is a monopolistic supplier of air transport to consumers. In order to be al-lowed to land on the airport and to use the airport facilities, the carrier has to pay a landing fee.
whereα >0is the slope of the linear demand curve andD >0the ordinate intercept. Ticket demand is higher the lower the ticket price pc demanded
by the carrier.
Airport revenues consist of aviation and non-aviation revenues. Besides the income originating from aeronautical activities, pa·x, where pa >0 is
the landing fee charged from the airline, the airport generates income from commercial activities, s·βx.1 Commercial revenues may comprise direct income from shops, restaurants, car parks, etc. if these facilities are run by the airport itself or concession income if they are run by franchises and other commercial operators. For simplicity, we assume that one commercial product is offered at the airport and each passenger buys a quantity of0< β ≤ 1. Hence, β can be interpreted as the degree of complementarity of aviation and non-aviation at the airport. Further,s >0is the locational rent earned by the airport by offering the commercial good or by renting property to a franchise or a commercial operator (Forsyth 2004). The locational rent arises from the superior location of the commercial property.
The airport’s costs consist of fixed costs that include capital costs such as depreciation and a normal rate of return on capital,F >0. A share 0< λ≤1 in the airport’s costs can be assigned to aeronautical activities, while the remaining share1−λis related to commercial activities. Consequently, the airport maximizes the profit for the forthcoming flight period
(pa+sβ)·x−F
by charging an optimal landing feepa from the air carrier.
The air carrier maximizes its profit by demanding an optimal ticket price pc from its passengers. For simplicity, we assume that the only cost accruing
to the carrier when operating a flight is the landing fee. Thus, the airline maximizes
(pc−c)·x(pc),
where the constant total cost per flightccorresponds to the landing fee paid to the airport, i.e., c=pa.
The timing of events is as follows. The airport has to determine the landing fee in advance for the forthcoming flight period. Within that flight period, the air carrier decides what ticket price to charge. Therefore, the game is a sequential game, the airport is assumed to be the first mover and the airline the second mover, and the prices and quantities discussed in the following are results of subgame perfect equilibria determined by backward induction.
1The landing fee is usually a function of frequency and tickets, and non-aviation rev-enues are a function of passengers. We assume that tickets, non-aviation revrev-enues and landing fees share, as a unit, a fully booked aircraft that minimizes landing fees.
3 OPTIMAL LANDING FEES AND AIRPORT PROFITS 4
3
Optimal landing fees and airport profits
The air carrier determines a ticket price that maximizes its profit. The optimal ticket price demanded from the passengers is
p∗c = D+αc 2α and the resulting demand for tickets adds up to
x∗ = D−αc 2 .
The airport anticipates the price decision of the air carrier and the derived ticket demand. Profit maximization by the airport results in an optimal landing fee charged to the airline,
p∗a= D−αβs 2α . Hence, the airport earns a positive profit
Π∗ = (D+αβs) 2 8α −F as long asF <F¯ = (D+αβs)2/8α.
Theorem 1 A profit-maximizing monopolistic airport that generates income both from aeronautical and commercial activities, i.e., β >0, has an incen-tive to restrain aeronautical charges. The optimal landing fee demanded from the airline,p∗a, is lower the higher the degree of complementarity of aviation and non-aviation at the monopolistic airport, β.
Proof: See the Appendix.
It is preferable to the airport to demand a lower landing fee than if run-ways were a stand-alone facility, i.e., β = 0, since the resulting rise in the volume of traffic,αβs/4>0, increases non-aviation revenues and thus raises the airport’s profit by (αβs)2/8α > 0. However, this does not imply that
the airport will never take advantage of its monopoly power in the aviation business.
Theorem 2 For a profit-maximizing monopolistic airport with fixed costs
F ≤D2/8αλ−(D−αβs)2/32αλ <F¯, the following results hold:
1. The optimal landing fee will be higher than the landing fee that a reg-ulator would approve, i.e., p∗a> prega , if aviation revenues exceed non-aviation revenues, i.e., βs/p∗a<1.
Proof: See the Appendix.
If aviation revenues account for the main share in total revenues, the airport will have an incentive to abuse its market power in the aviation business. The optimal landing fee lies above the cost-covering level for the aviation business, traffic is lower than it was in the presence of regulation, x(p∗a)−x(prega ) = (αβs−√D2−8αλF)/4<0, and the airport earns a positive profit by
pro-viding aeronautical services, Π∗Av = (D2 −(αβs)2)/8α −λF > 0. In this
case, a regulation of aeronautical charges is appropriate in order to reduce welfare-losses. In contrast, a regulation will be inappropriate if non-aviation revenues amount to more than 50% of all airport revenues. In such case, the airport will charge a landing fee that lies below the cost-covering level for the aviation business. The lower landing fee attracts additional traffic, x(p∗a)−x(preg
a ) > 0, which in turn increases non-aviation revenues. As a
result, non-aviation profits2(Dαβs+ (αβs)2)/8α−(1−λ)F >0 overcom-pensate aviation losses, Π∗Av < 0, and the airport earns a positive profit
Π∗ >0.
4
Conclusion
Monopolistic airports have an incentive to restrain aeronautical charges when they generate additional non-aviation revenues. Landing fees are lower the higher the degree of complementarity of aviation and non-aviation at an airport. Furthermore, our model shows that as soon as non-aviation revenues increase above 50% of all airport revenues, monopolistic airports will not take advantage of their market power anymore; therefore, price regulation becomes inappropriate.
Appendix
Proof of Theorem 1:
The optimal landing fee in the presence of non-aviation activities, p∗a, is lower than the fee p∗∗a that maximizes the airport’s profit in the absence of non-aviation activities, i.e.,β = 0:
p∗a= D−αβs 2α < D 2α =p ∗∗ a , since α >0,β >0 ands >0.
4 CONCLUSION 6
Furthermore, the optimal landing fee falls in the quantity of the commer-cial product purchased at the airport:
∂p∗a ∂β =− s 2 <0, becauses >0. Proof of Theorem 2:
A regulatory authority that confines regulation to the monopolistic bottle-neck of the airport will approve a landing fee that covers the average costs which can be assigned to aeronautical activities:
prega = λF
x(prega )
,
wherex(prega ) = (D−αprega )/2. Hence, the regulator will approve a landing fee of
prega = D−
√
D2−8αλF
2α ,
ifF ≤D2/8αλ. The optimal landing fee demanded by the profit-maximizing monopolistic airport will be higher than the regulated landing fee if
p∗a−prega >0, ⇐⇒ D−αβs 2α − D−√D2−8αλF 2α >0, ⇐⇒ βs p∗ a < 2 √ D2−8αλF D−αβs , ⇐⇒ βs p∗ a <1,
as long asF ≤D2/8αλ−(D−αβs)2/32αλ. In contrast, the optimal landing fee demanded by the airport will be lower than the regulated landing fee, if p∗a−prega <0⇔βs/p∗a>1.
ternational Journal of Industrial Organization 26, 1015-1031.
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Forsyth, P., 2004, Locational and monopoly rents at airports: creating them and shifting them, Journal of Air Transport Management 10, 51-60.
Graham, A., 2009, How important are commercial revenues to today’s air-ports?, Journal of Air Transport Management 15, 106-111.
Oum, T.H., Zhang A., Zhang Y., 2004, Alternative Forms of Economic Reg-ulation and their Efficiency Implications for Airports, Journal of Transport Economics and Policy 38, 217-246.
Sieg, G., 2009, Grandfather Rights in the Market for Airport Slots, Trans-portation Research Part B, in press.
Starkie, D., 2001, Reforming UK Airport Regulation, Journal of Transport Economics and Policy 35, 119-135.
